During a conference call this past Friday, Don Coxe, who is the Chairman and Chief Strategist of Harris Investment Management and Chairman of Jones Heward Investments, stunned listeners when he suggested that "there's rumors the Saudis are going to move off their peg to the dollar."

The rumor comes on the heels of the Fed's 50 basis-point rate cut, which is being hailed on Wall Street as appropriately aggressive and reviled in the bond market as inflationary.

I think it's a bald-faced bailout of the credit system, and a ham-handed attempt to restore faith in the monetary system worldwide. If you're like me, your faith was gone long ago, and sure, the markets are exuberant in their short-term reaction, but the U.S. dollar has sunk to new lows against most currencies.

If a real rout of the U.S. dollar materializes in the form of wholesale dumping by foreign reserve holdings, then obviously the U.S. is going to suffer severe economic recession.

In a letter written to the Financial Times on September 19 by Richard Dale, professor of International Banking at Southampton University in the U.K., he relates the following cautionary tale:

In May 1984, Continental Illinois, then the seventh-largest bank in the US, suffered a devastating run. Having only a small retail deposit base, the bank had expanded its loan book rapidly by borrowing heavily in the wholesale money markets. When doubts began to arise about the quality of Continental's loan portfolio, it was abruptly shut out of the money and capital markets and was forced to borrow from the Federal Reserve.

The Comptroller of the Currency stated publicly that the bank was solvent and adequately capitalised; the US central bank indicated that it was prepared to provide open-ended liquidity support; and the US Federal Deposit Insurance issued a statement effectively extending 100 per cent deposit insurance to all depositors and general creditors of the bank. Despite these initiatives, confidence in Continental was destroyed, the withdrawal of funding continued unabated and, in the absence of any private buyers, ownership of the bank was eventually transferred to the Federal Deposit Insurance Company in July of that year.

The Northern Rock crisis is almost a precise re-run of the Continental Illinois collapse. The immediate cause of the problem--over-rapid balance sheet expansion funded through wholesale markets--is the same. The progressive official interventions--statements on solvency, open-ended liquidity support and now the guaranteeing of deposits--are being repeated. But confidence has yet to be restored and the ultimate ownership of Northern Rock is in doubt.

There are two clear lessons in all this. First, once confidence is lost it is very difficult to get it back: if there is criticism of the Bank of England, it is not that it bailed out Northern Rock but that it underestimated the potential for a contagious financial collapse. The Bank should have offered 100 per cent deposit insurance on day one of the crisis and before queues started to form outside Northern Rock branches. Second, depository institutions that engage in large-scale maturity transformation (borrowing short and lending long) should be funded largely from captive retail deposits and not from fickle wholesale markets. How the UK Financial Services Authority overlooked this fundamental precept should be a matter for investigation.

Finally, when the dust eventually settles on this global banking crisis, there may be a case for reviewing the fusion of banking and securities markets that has occurred following the abolition of the US Glass-Steagall Act a few years ago. Arguably, the core banking system should be kept separate from the innovative risk-taking that is the lifeblood of the securities markets.

Embedded in a story on the front page of the Financial Times on September 19 was this little snippet in an article entitles "Lehman Results Bring Cheer to Wall Street":

Lehman overcame a 47 per cent decline in revenues from fixed-income capital markets. Its earnings were boosted by a lower tax rate and the use of a new accounting rule allowing it to book as profits the reduction in market value of some of its debts.

Alex Pollock of the American Enterprise Institute astutely commented,

In other words, if the "fair market value" of your debt goes down--perhaps because the bond market considers you a worse credit risk--while you owe exactly the same amounts to your creditors as you always have, you can then declare a "profit." The "fair value" accounting theorists have thereby arrived at absurdity.

George Orwell appears to have accurately predicted the government's willingness to employ "doublespeak" to turn fictions into truths and truths into realities.

The one constant in all the bad news interspersed with PR doublespeak in all of the mainstream press is the fact that nobody wants to admit that confidence in the system has been lost, and that the cause of the loss is reckless fiduciary irresponsibility on the parts of government, financial institutions, and, as a result, John Q. Public shooting off his credit bullets faster than a Gatling gun.

The beneficiary of the weakening U.S. dollar has once again been gold. But with Warren Buffet even officially on the gold bug bandwagon, that's a roller coaster that is still cranking its way up, with no downside in sight.

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